Inventory management is central to business success, encompassing raw materials to finished goods, and the costs of ordering, holding, and shortages. Effective management affects profitability, operational efficiency, and financial reporting. Different inventory accounting methods, such as FIFO and LIFO, influence key financial metrics and strategic decision-making, highlighting inventory's importance in business operations.
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Inventory refers to the goods and materials a company maintains for sale or use in production
Cost of Goods Sold (COGS)
Inventory affects the cost of goods sold on a company's income statement
Categories of Inventory
Inventory is categorized into raw materials, work-in-process, finished goods, and MRO supplies
Proper inventory management is crucial for maintaining profitability and operational efficiency
Raw materials are the basic inputs required for manufacturing products
WIP inventory includes items in the production process, incorporating raw materials, labor, and overhead costs
Finished goods are the final products ready for customer purchase
MRO supplies are essential for maintaining the production process and are also accounted for in inventory
Ordering Costs
Ordering costs refer to expenses incurred in placing and receiving orders
Holding Costs
Holding costs include storage, insurance, and obsolescence
Shortage Costs
Shortage costs arise from stockouts, which may lead to lost sales and a tarnished company reputation
Accurate cost accounting is crucial for financial reporting and effective business management
Inventory accounting involves recording and reporting inventory transactions and balances
FIFO (First-In, First-Out)
FIFO assumes that the oldest inventory items are sold first, potentially leading to lower COGS and higher profits during inflationary periods
LIFO (Last-In, First-Out)
LIFO assumes that the newest inventory items are sold first, potentially resulting in higher COGS and lower profits during inflation
Weighted Average Cost
Weighted average cost takes into account the average cost of all inventory items
Specific Identification
Specific identification assigns a specific cost to each inventory item
The chosen inventory valuation method can significantly affect financial outcomes and key metrics such as COGS, gross profit, net income, and total assets
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Inventory Categories
Raw materials, WIP, finished goods, MRO supplies.
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Impact of Inventory on COGS
Inventory levels directly affect the cost of goods sold on income statements.
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Inventory Management Goals
Aim to maintain profitability and operational efficiency through effective inventory control.
